Collateral = risk capacity January 29, 2013 at 10:26 am

US GC repo is going lower, because, well, the Treasury has most of the assets, thanks to QE. Given that these assets are needed for collateralised funding and collateralised risk taking, that is having an impact. Izzy at Alphaville relays the following, very much along the line we have taken on this:

overly strict collateral policy, implemented post crisis, is now constraining the market’s ability to take on risk, because the ability to fund or run “risk-on” trades is determined by how many safe assets an institution has available for margin posting.

Risk positioning is increasingly being held back by a static pool of risk-free collateral.

Furthermore, if and when the risk positions sour, that divide only gets wider as further safe collateral calls are made, sucking more safe assets out of the system.

You can’t both demand that funding and risk taking are often collateralised then buy up most of the collateral without it having an impact.

4 Responses to “Collateral = risk capacity”

  1. Why doesn’t the market work around that problem by moving to more option like products, which have the same risk characteristic without the collateral requirements (assuming both the risk on and risk off sides meet on the options market, it obviously doesn’t work if one side is hedging with classic collateral-intensive things)?

  2. Because they have horrible liquidity risk; as you get further in the money, you have to post more collateral. Remember collateral agreements apply to derivatives too.

  3. I didn’t have raw options in mind, but limited risk combinations. It should only take away the ability to take (unwanted) tail risks, but I may be missing something.

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